Owning vs. leasing your restaurant equipment is very similar to the purchase vs. lease options for a vehicle. In either case, cash flow and immediate tax deductions are two areas to focus on. However, first and foremost, always negotiate the best purchase price of the equipment before deciding how to pay for it. For any asset purchases, the first focus should be the desired need and the value you will be receiving. In other words, get a good deal!
When leasing equipment, your cash outflow is lower, since the concept is similar to a rental fee plus interest. Of course, at the end of the lease term, you will not own the equipment. Therefore, in the early stages of a restaurant operation or when a major purchase would restrict cash flow if the item was purchased outright, leasing is a viable option to allow time for the asset to contribute to growth in sales for the restaurant. This asset may be a new cooler that allows increased storage of food items to expand the menu; a new fryer to increase output of appetizers; or the purchase of a new POS system to track transactions in the restaurant.
Whether a transaction is a lease or a purchase determines, for tax purposes, who is entitled to the deduction for depreciation on the property. In making this determination, the substance of the transaction, and not the terms used by the parties, is the controlling factor. Criteria for determining whether a transaction is a leasing arrangement or a purchasing arrangement are:
1. Does lessee acquire full or partial equity in the property through lease payments?
2. Does lessee acquire the title to the property after the required number of payments?
3. Are total lease payments due in a relatively short period of time, and do they substantially cover the total cost of acquiring the asset?
4. Do lease payments substantially exceed the fair market value of the property?
5. Can the lessee acquire the property for a nominal sum at the end of the lease?
6. Does lessee provide loan guarantees or stop-loss guarantees to lessor?
7. Does the lessor have little or no investment risk in the leased property?
8. Is the lessee responsible for all costs and expenses of the lease, including taxes and insurance?
The lessee’s right to the leased asset is derived from the lease agreement. The agreement, though cast in the form of a lease, may in substance be a conditional sales contract. This determination is based on the intent of the parties in light of the facts existing when the agreement was executed.
No one factor is controlling; however, if one or more of the questions above is answered yes, indicating that the factor exists, the transaction may actually be a sales transaction rather than a lease. If a lease agreement is determined to actually be a sale, the lessee has to capitalize the property and recover the cost through depreciation. The lessee must impute a portion of the “lease” payment as interest expense, and is entitled to all of the deductions available to the owner of the property (taxes, maintenance, insurance, etc.).
Any asset purchased is allowed to be depreciated over its useful life. For example, a cooler with an estimated tax useful life of five years recovers the purchase price or cost by deducting (depreciating) this amount as an expense in a profit and loss statement. Over five years, this cost will be expensed against income of the operations based on methods assigned to each asset category by the IRS.
For restaurants that have net income, most furniture, fixtures or equipment with a five-or seven-year useful life are allowed to have accelerated depreciation deduction (within limits) to expense the entire cost in the first year.
Section 179 of the Internal Revenue Code allows corporations to expense up to $250,000 of tangible personal property (i.e., furniture, fixtures and equipment) used in the restaurants and placed in service during tax years beginning in 2009. The $250,000 maximum is reduced dollar for dollar by the excess of qualified property placed in service, during tax years beginning in 2009, over $800,000; and for tax years beginning in 2010, the maximum expensing deduction and the beginning-of-phase-out amount fall to an inflation-adjusted $134,000 and $530,000, respectively, unless Congress extends the higher limits another year (Revenue Procedure 2009-50).
Make your asset purchase a great value first. Seek out restaurants that might have gone out of business in your area and contact them; many local banks will still finance new and used equipment. Locate a few equipment leasing companies that specialize in new or used, and find out their requirements before you go shopping.
If cash flow to your restaurant is critical, consider leasing, but if your restaurant is generating net income, consider purchasing the equipment outright or through some form of financing from a lender so that you can take advantage of the immediate tax benefit.